What I’m Seeing That Has Me Concerned About the Volatility Index

I’ve had a great response to my Dow Award paper, Forecasting a Volatility Tsunami, with it being downloaded over 3,000 times since April. I really appreciate the support and the positive feedback I’ve received so far. Last week I had the opportunity to do a webcast with the Market Technicians Association, going into much greater detail about the importance of risk management and shedding some more light on the topic of the paper – low levels of dispersion within the VIX.

What I’m seeing today
As of June 16th (last Friday), the dispersion within the Volatility Index (VIX) (i.e. daily gyrations in in the index) has fallen below the threshold I highlighted in my paper. As I mentioned in my webcast and in the paper itself, I do not believe this ‘trigger’ alone is not enough to generate a final conclusion on the potential direction of the VIX and that in my own research I combine it with several other pieces of data. For example, low levels of dispersion in the Volatility Index is similar to clouds forming in the sky that often precedes rain storms, similar to how low dispersion in the VIX often precedes spikes higher. Just like being able to have dark clouds in the sky without rain, we’ve had periods of time where dispersion has been low for the VIX without it being followed by a spike higher. This is why we must continue our analysis in looking at other pieces of data for confirmation.

While last Friday sent the standard deviation (which is how I chose to measures dispersion) for the VIX to a very low-level, paired with some over factors I follow, has sent up a yellow flag for volatility in my opinion. Below is chart of the VIX with previous instances of what I’m seeing taking place right now. Since 2012 we’ve had this type of trigger occur before several intermediate and large swings within the VIX Index as well as at the end of 2010.  Most recently we saw three occurrences in August of last year before the Volatility Index rose over 70% and major U.S. indices weakened for several weeks.

Seasonality
I find it extremely interesting that this is occurring near the end of June, as based on seasonality, that has been when the Volatility Index has historically bottomed out. Thanks to Callum Thomas for the below chart, which he included in his weekly ‘chart storm’ over the weekend, showing the seasonal patterns for the S&P 500 and the VIX Index since 1990.

This post is not meant to act as a recommendation to buy or sell securities but to show an example of how I have incorporated volatility dispersion within my own research. We’ll see what the VIX does in the coming weeks.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

What’s In A Name?

“What’s in a name? That which we call a rose
By any other name would smell as sweet.”

Romeo and Juliet

One of my goals for 2017 was to read more. While I’m nowhere close to the Patrick O’Shaughnessy-level of 100+ books a year (Patrick’s book club is a great place to find new titles to read by the way), I am trucking along with my reading list and I’m currently in the middle of reading Pre-Suasion by Robert Cialdini. So far the book has been excellent and is one of my favorite books I’ve read so far this year. While not a finance-related book, there’s one section that stood out that is trading related and helped reinforce something I’ve believed for quite a while.

That is, that many make trading and the evaluation of stocks much more difficult than it truly needs to be. Hours are spent building complex spreadsheets, forecasting cash flows, counting cars in parking lots of retailers, analyzing changes in tone of a CEO during a media interview, etc. Meanwhile, (it’s of my belief that) the market rises and falls on the simple shift of human emotion and psychology which drives supply and demand for a stock. 

That’s where Mr. Cialdini comes in.

Below is a page of Pre-Suasion from a chapter in which Cialdini discusses the idea that people prefer topics and names to be as easy as possible to perform or say. For example, he cites a study that was looked at the names of lawyers and found that those with the hardest names to pronounce were less likely to advance up the ladder of their respective law firms. He also discussed the stock market and the performance of stocks with easy to pronounce names and ticker symbols. 

Seriously! From 1990 through 2004, stocks that had easier to pronounce names outperformed those with unpronounceable names. Now obviously what’s considered easy can vary by the eye mouth of the beholder. But this boils down to the notion that people are drawn to things that are simple – even when it comes to deciding where to invest the trillions of dollars that make up the U.S. financial market.


This is unlike to persuade many of those involved in our field from continuing to expand their spreadsheets with costs of goods sold and revenue projections; nor should it as there is likely value that can be derived from that practice. But it’s important to not lose sight of the idea that at the end of the day, supply and demand within the stock market is largely driven by human emotion. Well what about the HFT traders and all the algos? Sorry to disappoint you but those algorithms were originally written by humans too!

Einstein said “Make things as simple as possible, but not simpler” and he was right. I believe that’s why the concept of long-term trend following has been so effective for so many years. While being one of the simplest ideas of trading (but one of the toughest for investors to stick to), almost binary in its genesis. In fact, AQR showed an example of positive performance of trend following going back to 1880.

This isn’t a post arguing that trend following is superior over other methods or that discounting cash flow is a waste of effort. But to show the simplicity of human desire for the easiest and simplifed solutions, even when it comes to stock selection. At the end of the day basic emotion reins supreme in the search for the easiest route to decision making.

Source: Pre-Suasion: A Revolutionary Way to Influence and Persuade by Robert Cialdini

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Price and Seasonal Weakness Plague Mid Cap Equities

Last week I discussed the growing divergence within the S&P 500 as the largest components of the index were outperforming the smaller $SPX stocks. To continue on that topic, below we’re going to look at the S&P 400 Mid Cap Index.

$MID recent made a run back to its prior 2017 high but was unable to breakout, creating a lower high in momentum, based on the Relative Strength Index. This creates the third major lower high since its December as momentum continues to weaken for this mid cap index.

While the 100-day Moving Average was able to provide some support during the low earlier in the year, price has unable to gain transaction along with the large cap U.S. equities. The bottom panel of the chart shows the relative performance of the S&P 400 vs. the S&P 500. With relative performance having peaked in December, the ratio line has been putting in a series of lower highs as mid caps struggle to keep up. While price is still well off its prior low, relative performance is beginning to creep closer to its 2017 low, a bad sign for mid cap stocks.

Looking at volume on this daily chart, we can see a recent increase in large selling days. In early April we saw three consecutive above-average days of selling as a short-term low was put in for $MID. However, more recently two more days of above-average down volume have taken place – a sign that many traders attribute to institutional selling.

Turning our focus to seasonality, this recent weakness in the mid cap index begins to make a little more season. Based on the below chart from EquityClock, over the last 20 years, the S&P 400 has put in a short-term high in early May before picking back up later in the month

Going forward I’ll be watching to see how $MID acts if price gets back to the prior ’17 low and if the relative performance ratio does in fact set a new low. This period of weakness does align with long-term seasonality and if the seasonal pattern continues to play out we could see mid caps weaken further until later this month.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.